Here’s why stock volatility likely won’t end in April

The U.S. stock market has seen a number of dizzying swings over the past two months, and while investors shouldn’t expect that to end anytime soon, the catalysts for the moves may shift from macroeconomic events like trade policy and inflation concerns to company-specific news.

Markets are gearing up for the first-quarter earnings season, when corporate America will release its results for the first three months of the year and provide guidance for the rest of 2018 and beyond. Earnings will likely be a huge driver of markets over the month of May — when the season will be in full swing — but the earnings-related volatility could come earlier.

According to Goldman Sachs, the first three weeks of April are a popular time for companies to preannounce their results, and given the number of issues investors are looking for clarity on — including the impact from the recently passed tax bill, the prospect of protectionist trade policies and whether management teams are seeing any sign of inflation or impact from higher interest rates — such announcements could prove pivotal for traders.

Courtesy Goldman Sachs

However, investors may not be fully anticipating the volatility that could arise from such preannouncements, the investment bank wrote.

“The options market is pricing in earnings volatility in April week 4 and May week 1. However, they are not pricing in elevated volatility for April weeks 1, 2 & 3, the peak of preannouncement activity historically,” wrote Katherine Fogertey, an options strategist at Goldman.

The technology sector, which has recently been in focus due to the massive swings it has seen, could be particularly susceptible to this kind of volatility. According to Goldman, fully 33% of April preannouncements are done by companies in that sector. The consumer-discretionary sector and health care followed it in a sector breakdown (17% of preannouncements come from discretionary stocks, while 14% are in health care).

The firm recommended buying straddles on these names, referring to an options strategy where an investor buys a bullish call option and a bearish put option at the same strike price. This is a bet that a security will move by a certain amount, as opposed to in a specific direction, making it essentially a bet on volatility.

“If investors see a fundamental basis for elevated preannouncement potential, often options provide a very attractive way to express this view by positioning for earnings volatility further ahead of the earnings event than normal,” it wrote. “If the company does provide an update ahead of results, they capture two earnings events for the price of one. But, if the update does not occur, often they just face losing just the time decay of the options — which could be partially offset if implied volatility rises ahead of earnings.”

In a sign of the overall market’s volatility in 2018, the Cboe Volatility Index has more than doubled year to date, and last traded at 22.68, a level that is only sightly above its long-term average of 20. However, the Dow Jones Industrial Average
DJIA, +0.84%
, the S&P 500
SPX, +1.09%
and the Nasdaq Composite Index
COMP, +1.42%
have all seen huge swings in both directions.

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